Techical Analysis: Inverse Head and Shoulders

June 01, 2022

The Inverse Head & Shoulders is a bullish reversal pattern that can be found after a downtrend. The principle of the pattern is identical to that of a triple bottom, with the exception that the second trough is lower than the other two.

It resembles its name where price first forms a low (left shoulder), followed by a lower low (head), and then another lower low (right shoulder). After every low price touches the neckline which works as a resistance during head and shoulder formation. Rising through the neckline after forming the third low confirms the pattern. It doesn’t matter whether the neckline is a straight horizontal line or has a slope; the only thing that matters is the neckline should be able to connect the two highs of the first two lows. It has been observed that a neckline with an upslope has higher performance than the straight or downward sloped neckline.

Let’s discuss some key parts of the pattern individually including the volume to have deep insight into the pattern.

  • Prior trend: For a valid head and shoulder, it should be formed after a downtrend.

  • Shoulders: Formed by the first and third troughs (lows) and are approximately the same height.

  • Head: Formed by the second trough that is lower than that of the shoulders. Preferable 1.5 to 2 times lower.

  • Symmetry: The spaces between each trough must be similar to validate the inverse head and shoulder pattern.

  • Neckline: Is determined by the two highest points reached after the first shoulder and the head. These two high points are not always at the same level; the neck line can therefore be upward (38% of cases), downward (40% of cases) or horizontal (22% of cases).

  • Volume: Volume plays an important role during the formation and confirmation of the validity of the pattern. Volume increases during the advancement of the left shoulder but decreases when the price bounces to form the head. After forming the second peak, the volume increases and decreases again while going for the third peak. This volume trend gives the warning sign when price makes the 3rd peak and mostly likely completes the pattern by breaking the neckline with an increasing volume.

Trading a head and shoulder pattern

Trading without confirmation of a pattern equals to committing suicide. In the Inverse head and shoulder pattern the breakdown of the neckline with high volume gives the confirmation of the pattern and you can take a long trade after that breakout or in the retest of the neckline; but never chase a trade that is already gone. Make sure to place the stop loss below the right shoulder while opening a long trade, think of moving it below the neckline as the trade advances for better risk management. The target of the inverse head and shoulder is equal to the size of the difference between the neckline and head low but you should use the Fibonacci retracement tool to confirm the targets.